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# PV analysis including incometaxes, & PV of cash inflows

I need help with the calculation of the CCA tax shield and present value for two projects.

1. Present value analysis including income taxes
The X Cafeteria employs five people to operate a dishwashing machine and the cost of wages for these people and for maintemence of the equipment is \$85,000 per year. The management is considering the purchase of an automated machine that cost \$160,000 and have a useful life of 12 years. This machine would require the service of three people to operate at a cost of \$48,000 per year. A maintenance contract on the machine cost an additional \$12,000 per year. New water jets would be needed on the machine in six years at a total cost of \$15,000.
The old equipment is fully depreciated and has no resale value. The new machine would have a salvage value of \$9,000 at the end of its 12 year useful life. Management requires a 14% rate of return on all equipment purchases. The company's tax rate is 30% and CCA is 20%

a) Determine the before tax net annual cost savings that the new dishwashing machine will provide.

The net annual cost savings would be:

Reduction in labor costs \$85,000 - \$48,000) \$37,000
Less increased maintenance costs (\$2,000 × 12) 24,000
Net annual cost savings \$13,000

b) Using the data from (1) above and other data from the exercise, compute the new dishwashing machine's net present value. Would you recommend that it be purchased?

Item Year(s) Amount of Cash Flows 14% PV Factor Present Value of Cash Flows
Cost of the machine Now \$(160,000.00) 1.000 \$(160,000.00)
Annual cost savings (above) 1-12 \$- 5.660 -
Replacement of parts 6 \$(15,000.00) 0.456 (6,840.00)
Salvage of the new machine 12 \$9,000.00 0.208 1,872.00
Net present value \$(164,968.00)

Present value of CCA tax shiled = ?

2. Present value of cash inflows

Annual cash inflows that will arise from two competing investment projects are given below

Investment
Year A B
1 \$3,000 \$12,000
2 6,000 9,000
3 9,000 6,000
4 12,000 3,000
\$30,000 \$30,000

Each investment project will require the same investment outlay. The discount rate is 18%. Compute the present value of the cahs inflows for each investment.

#### Solution Summary

1. Present value analysis including income taxes
The X Cafeteria employs five people to operate a dishwashing machine and the cost of wages for these people and for maintemence of the equipment is \$85,000 per year. The management is considering the purchase of an automated machine that cost \$160,000 and have a useful life of 12 years. This machine would require the service of three people to operate at a cost of \$48,000 per year. A maintenance contract on the machine cost an additional \$12,000 per year. New water jets would be needed on the machine in six years at a total cost of \$15,000.
The old equipment is fully depreciated and has no resale value. The new machine would have a salvage value of \$9,000 at the end of its 12 year useful life. Management requires a 14% rate of return on all equipment purchases. The company's tax rate is 30% and CCA is 20%

a) Determine the before tax net annual cost savings that the new dishwashing machine will provide.

The net annual cost savings would be:
Reduction in labor costs (\$85,000 - \$48,000) \$37,000
Less: Increased maintenance costs \$12,000
Net annual cost savings \$25,000

b) Using the data from (1) above and other data from the exercise, compute the new dishwashing machine's net present value. Would you recommend that it be purchased?

Item Year(s) Amount of Cash Flows 14% PV Factor Present Value of Cash Flows
Cost of the machine 0 (\$160,000) 1.000 \$(160,000.00)
After tax cash flows 1 \$22,300 0.877 \$19,561.40
After tax cash flows 2 \$26,140 0.769 \$20,113.88
After tax cash flows 3 \$24,412 0.675 \$16,477.40
After tax cash flows 4 \$23,030 0.592 \$13,635.37
After tax cash flows 5 \$21,924 0.519 \$11,386.47
After tax cash flows 6 \$21,039 0.456 \$9,585.06
Replacement of parts 6 (\$15,000) 0.456 \$(6,840.00)
After tax cash flows 7 \$20,331 0.400 \$8,125.09
After tax cash flows 8 \$19,765 0.351 \$6,928.77
After tax cash flows 9 \$19,312 0.308 \$5,938.57
After tax cash flows 10 \$18,950 0.270 \$5,111.52
After tax cash flows 11 \$18,660 0.237 \$4,415.20
After tax cash flows 12 \$18,428 0.208 \$3,824.84
Salvage of the new machine 12 \$9,000 0.208 \$1,868.03
Tax shiled on loss on sale 12 \$1,011 0.208 \$209.81
Net present value \$(39,868.38)

After tax cash flows
Net annual before tax cost savings Depreciation @ 20% Taxable base Tax @ 30% Net after tax cash flows Undepreciated capital cost
\$160,000
1 \$25,000 \$16,000 \$9,000 \$2,700 \$22,300 \$144,000
2 \$25,000 \$28,800 (\$3,800) (\$1,140) \$26,140 \$115,200
3 \$25,000 \$23,040 \$1,960 \$588 \$24,412 \$92,160
4 \$25,000 \$18,432 \$6,568 \$1,970 \$23,030 \$73,728
5 \$25,000 \$14,746 \$10,254 \$3,076 \$21,924 \$58,982
6 \$25,000 \$11,796 \$13,204 \$3,961 \$21,039 \$47,186
7 \$25,000 \$9,437 \$15,563 \$4,669 \$20,331 \$37,749
8 \$25,000 \$7,550 \$17,450 \$5,235 \$19,765 \$30,199
9 \$25,000 \$6,040 \$18,960 \$5,688 \$19,312 \$24,159
10 \$25,000 \$4,832 \$20,168 \$6,050 \$18,950 \$19,327
11 \$25,000 \$3,865 \$21,135 \$6,340 \$18,660 \$15,462
12 \$25,000 \$3,092 \$21,908 \$6,572 \$18,428 \$12,370

Note: Half year rule applied in the first year for depreciation calculation.
Assumed that the purchase of new water jets is a revenue expenditure

Tax shield on machinery - Year 12

Salvage value \$9,000
Undepreciated capital cost \$12,370
Loss (\$3,370)
Tax shield @ 30% \$1,011

2. Present value of cash inflows

Annual cash inflows that will arise from two competing investment projects are given below

Investment
Year A B
1 \$3,000 \$12,000
2 6,000 9,000
3 9,000 6,000
4 12,000 3,000
\$30,000 \$30,000

Each investment project will require the same investment outlay. The discount rate is 18%. Compute the present value of the cahs inflows for each investment.

Investment 18% PV Factor Present value of cash flows
Year A B A B
1 \$3,000 \$12,000 0.847 \$2,542 \$10,169
2 6,000 9,000 0.718 \$4,309 \$6,464
3 9,000 6,000 0.609 \$5,478 \$3,652
4 12,000 3,000 0.516 \$6,189 \$1,547
\$30,000 \$30,000 \$18,519 \$21,832

\$2.19